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Issue v0.10 – Valley vs. The Rest: The State of the Venture Capital Industry

The prominence of technology is riding high, with billion dollar initial public offerings (IPOs), news of large acquisitions, and a seemingly egalitarian spree in mobile applications pushing the profile of the industry up among the public; you can’t open a newspaper today without seeing story after story not just profiling firms, but even fashion and intrigue in the technology sector.

The old joke is that if your taxi driver gives you stock tips, it’s time to sell. Take a ride in San Francisco today, and try to find a taxi driver – and why are you taking a taxi and not one of the several new car sharing services in the city? – that doesn’t sport a smartphone and know about Facebook’s IPO. Consumer-facing technology companies and their financial moves, buying, being acquired, flaming out, and going public, are now common conversation.

That combined with the recent brouhaha over bills that directly impact technology and its industry, think SOPA, PIPA, and CISPA, and our little niche of the business world has mindshare with the public on par with few times in its past.

Then there is talk of a bubble. This means different things to various people. Some called technology bubblish as Facebook went public, which must mean things are crazy, right? Well, if you ever hear that line, just quote them Facebook’s expected profits for 2012. Most folks confused about that riff can’t read a cash flow statement. But we digress. The more sophisticated critic will state that there is a bubble in investment, that companies are finding it too easy to raise capital. This is the question that TNW hopes to explore, and respond to in this piece.

Is it too easy to raise money? And if so, where is it best to do so? The obvious answer would be everyone’s favorite stretch of Sand Hill Road, the Wall Street – in the ‘street’ sense – of blue chip investment houses. While we explore the question of the ease of raising capital for a company, we shall frame the discussion as one comparing investing and raising in the Silicon Valley area – from here on out just the ‘Valley,’ by which we mean San Francisco, the Bay Area, and the traditional Silicon Valley itself – to other markets.

TNW has spoken to a number of investors, and entrepreneurs, talking through the current investment climate.

We begin away from the Valley.

The Competition

It’s possible to raise money not in the Valley. Angels, angel networks, and venture capital firms exist around the United States, meaning that in any major city there is capital poised to spring into action. However, is there enough to support an ecosystem in an area? There is a positive effect to having an active ‘scene’ in a city, in which entrepreneurs help one another, investors can circulate and meet up and comers, and larger companies can keep tabs on smaller firms that they might want to snap up. Also, the more active a scene is, the more access to lawyers and other required extras can be found; if there is enough business to be had, service providers that are critical to a functioning early stage technology company’s life pay more mind to the market category of technology.

You can even raise huge sums outside of the Valley. A good example of this is the massive $55 million round that chip company Calxeda, a firm based in Austin, put together this past week. Highland Capital Partners, a Massachusetts venture capital firm, and local, Texas-based cash was present; key in the round was Austin Ventures. Texas Instruments, still headquartered in the Lone Star state, took part as well.

Not every firm is as successful in raising as Calxeda. Among the entrepreneurs who spoke to us – often on background to prevent offending investors in their local market – several stories stuck out as worthy of sharing. We begin in Boston.

“I don’t want to alienate anyone,” one founder told TNW, but “being situated in Boston right now, I’ll say that the fundraising ‘process’ here is a very irritating and mind-numbing experience.’ There are a “million” people waiting to waste your time, he went on to say. What’s the problem? The local investment scene appears to be comprised of “a bunch of business school guys who will rip through financials to validate what they learned during their MBA experience before they pull the trigger on anything.

The effect of this is that “people subsequently go out to the Valley” where people “get it.” In short, the sort of support and investment that is viewed as normal in the Valley can be hard to find in Boston. Does that mean that companies should not raise funds in the Boston Area? Of course not. But this does indicate that certain types of companies may have a harder time in Boston raising, than they might in other locations.

In other areas, problems can be found as well. We now head to another plot on the upper East Coast.

A startup has a $1 million grant to manufacture its product in a New England state. But the CEO is tempted to leave the grant behind and move the company to the Valley, simply because fundraising is a damned mess where he is currently located. Abbi Vakil, current investor in the company, told us the story:

“[The CEO] is thinking of foregoing that [grant] money because he can raise more by being in the San Francisco area. I have a small stake in the company, and they’ve opened a West Coast office in one of my buildings. As soon as he printed business cards with a Santa Clara address, a lot more doors began opening. Now he’s thinking of moving his family and business operations to the Bay Area, even though, the housing situation is out of control.”

These two examples outline what I think is essentially a rule: you can raise money successfully outside of the Valley, but you can only go so far downmarket. Cities such as Chicago and New York City and perhaps Seattle contain all the required pieces for a fully developed startup ecosystem. Upstate New York, Boston, Providence, New Orleans, Kansas City – add to the list as you wish – likely don’t.

Thus, to try and raise in what you could call a non-prime market is tough. But what about Calxeda? Well, think back to the example. It’s a chip company in a region that has given spawn to other chip companies; it took cash from one of the most successful chip companies in the world. It was founded nearby. That’s another take away: regions have personality.

I can attest to this. Chicago, a startup and technology scene that I know intimately from time spent living there, places a higher performance on financial performance of companies when they are young than folks do in the Valley. It’s a source of pride, among the Chicago crew, to point out their revenue focus, and mock the laxity of income as requirement among both investors and founders in the Valley. That said, try to raise a few million without firm traction in Chicago and see how often you get laughed at.

Returning to our point concerning that fundraising is possible outside the Valley, but far simpler in the more developed regions, TNW spoke to a founder who had recently raised just south of $1 million in the Chicago area. His comments bely a second truth: You can often find solid investors outside of the Valley provided that you have the network, but you might not get the same valuation that you might have secured in the Valley. That said, this founder noted that the shift in startup valuations will be less “volatile if the economy changes” in Chicago.

How well is Chicago itself doing? Investors are starting to leak backwards to the city for its demo day events. Rewind the clock three years, and try to find one incubator or accelerator in the city. Now you trip over the damn things.

Just glancing at New York, one can see a growing set of firms, with both an active technology scene, and at the top, exceptionally talented investors. We don’t need to dwell on Manhattan, it explains itself.

To add an international flavor to this: Canada is on the rise, according to Jonathan Ehrlich, COO of Copious, a company currently headquartered in San Francisco. In the last three years activity has picked up, the result of which is that “more and more, Canadian companies don’t have to come south.” If the companies don’t have to leave to secure capital, they can plant seeds at home for new startup ecosystems; out of little, more.

Our Chicago founder signed his email with the following, which will serve as a maxim in a pinch: “Money will follow successful entrepreneurs.” Indeed. It’s just easier to find it in a place where there is more of it, even in today’s somewhat heady times. With that, let’s go to California.

The Valley

Please meet Jacob Mullins, venture capitalist at Shasta Ventures, a firm that makes its home on our aforementioned Sand Hill Road. If you were looking for an example of a California VC, Jacob would be a good fit. TNW spoke with him on the current investment climate, to which he explained what makes the Valley a unique place:

“The investing sentiment in the Valley right now is very exciting. [T]here are a few trends contributing to the high level of activity. One: because it takes less money to get an MVP up and running more people seem to be trying their hand at the startup game. Two: more individuals are coming to the table as angel investors, enabling products to take flight as companies more often. Three, with exciting exits on the private M&A side such as Instagram and Yammer and others, and the IPOs of Facebook, LinkedIn, etc. we’re seeing some high profile and tremendous wealth being created for a large number of people. These people all live and work within an hours’ drive of each other, and their success contributes to the aspirational opportunity that is so palpable in Silicon Valley, on both the company building and investing side. To me, it’s the inordinately high concentration of startups and entrepreneurs, unlike any other area in the world, that feed this cycle.”

There is an awful lot in there, so let’s pull out the key pieces that we shall focus on: building something simple is now simple, allowing a great number of people to tinker; the number of angel investors is rising, as the total dollar amount required to invest falls – see previous point; big exits are driving optimism; and finally, all this stuck together in that very small place we call the ‘Valley’ leads to an updraft.

Given the focus we have put in the last few thousand words on the importance of a startup ecosystem in a city, this is familiar territory. However, what Jacob is saying in effect is that if some is good, more is better, and there is no higher concentration of technology entrepreneurship and investment than in the Valley.

TNW spoke with Chris McCoy, founder at YourSports, an entrepreneur who recently raised $400,000. His story underscores just what Jacob was discussing:

“We raised from investors in Silicon Valley this summer. I met one serendipitously at a Starbucks in Cow Hollow in San Francisco while I was couch surfing looking for a place to stay. He casually mentioned “I’m investing” so we set up a demo. He invested. He helped us close a few other investors so we got lucky there.”

Meeting an investor at a coffee shop may sound like something from a poorly thought out plot for a sitcom about technology, but in this case, it’s true.

Chris went on to compare investors from other regions in the following way:

“I believe the sheer number and dollars into angel/seed investments has increased over the past two quarters, certainly the past year. There are more people at the table to invest in businesses. […] We, at Shasta Ventures, primarily focus on the Series A stage and the volume (i.e. sheer number) of startups going through a Series A process has certainly increased.”

Acceleration. You don’t have to raise money in the Valley, but it’s a good time to do so if you had a hankering.

Tha Hustle

Let’s go over a few facts: you can start a company anywhere, and succeed. There is money in every city that could potentially become invested in your business. You don’t have to move. There are markets in which it is less difficult to raise money, but TNW sees little indication that it has become easy anywhere.

Chris, our founder who ran into an investor at Starbucks? His chief advice is this: “Hustle. It’s not easy [to raise].”

This is key, but something hackable, in a sense. If you want to raise money at home, and not from the Valley, you might have to do both. Jonathan Ehrlich, the previously mentioned Copious executive told TNW the following, and I condense slightly: “The Valley acts as the great validator. If you can raise here, it makes fundraising back home much easier. The rules of the Valley for fundraising are also very different than say, East Coast Money.” To that I would add: and Midwest money.

The Future

Returning to our initial questions, it would appear that while there is a full amount of investment activity going on, it feels far more sober than in previous bubble moments, and I leave it to you to classify the current landscape in that regard. Certain non-Valley markets are maturing, and are now well on their way to having the fortuitous mix of ingredients out of which springs a fully functioning startup ecosystem. Chicago, New York, and Seattle are either already there or on their way. Portland is up and coming, and so on.

It’s a damn fine time to start a company. However, don’t expect someone to hand you a term sheet. You’ll need both a launched product, and user engagement figures – and in Chicago, revenue – to land the funds that you want. The declining cost of building means that you are now expected to build before you raise.

Come to the Valley or not, the money is there. Get busy.

A short coda on exits

Given the disappointing performance of a number of recent technology IPOs – Facebook, Groupon, Zynga – doesn’t that cut down on what a growing company is ‘worth,’ if a key path to liquidity appears rough? In a sense, yes, but it’s critical to keep in mind the total cash positions of large technology companies. Facebook has $10 billion. Microsoft, Google, Apple have around $200 billion betwixt them (that’s rough math, so no whining). While the IPO route is hardly clear and open, there is enough built up cash-pressure to allow for exits of a hundred companies. That might not be the route that you want to take, but it does exist. Food for thought.